1st July 2011 by Shaun Richards
Whilst much of the world’s focus was on Greece yesterday another event was taking place which could easily turn out to be more significant with much less of a fanfare in the media. Not long after the Greek government won the second stage of its austerity package vote the US Federal Reserve undertook its last asset purchases of US government bonds under what has become called QE2. As it has purchased a total of US 600 billion dollars in eight months this means that it has bought an average of 75 billion dollars a month. Put another way since this programme started the US central bank has purchased around 70% of the debt its government has issued.
This is not a complete end to Federal Reserve purchases of US government bonds however as it has another programme which purchases them with funds received from maturing mortgage backed securities that it has in its portfolio. However this is a much smaller programme which purchases between 15 and 25 billion dollars per month depending on how many MBSs actually mature. As you can see the scale of purchases going forwards will be much reduced.
What did the US government bond market do in response to this?
I wrote yesterday that US government bond yields had risen strongly this week with the ten-year maturity whose yield closed below 2.9% on Friday rising to 3.11% at Wednesday’s close. This rallying of yields continued as the ten-year yield closed at 3.16% meaning that this week alone we have seen more than a quarter point rise in the yield on these bonds.
So there has been no sign of a post Greek agreement rally here as the rise in yields means a fall in prices. I am also reminded of the press conference given by Ben Bernanke the chairman of the US Federal Reserve announcing the end of QE2 when he stated that pre-announcing its end would mean that by the time it happens markets will just shrug it off. We are very rarely able to look at one event in isolation but it does appear that the end of QE2 has led to a rise in US government bond yields and perhaps more worryingly for the programme they are now higher than when it started. So as reducing them was an objective of the plan it did not succeed in achieving this as instead ten-year yields have risen by more than 0.6%.
The US unemployment situation
In my opinion the primary objective for the US Federal Reserve with its QE2 programme was to improve the US unemployment and employment situation. I have given quotes from their statements and speeches many times to evidence this. As QE2 progressed it looked like some success was being achieved in this area as unemployment fell and the employment situation improved. However recently this improving trend has turned downwards and if we look at yesterday’s figures for US initial jobless claims we can see the latest numbers.
In the week ending June 25, the advance figure for seasonally adjusted initial claims was 428,000, a decrease of 1,000 from the previous week’s unrevised figure of 429,000. The 4-week moving average was 426,750, an increase of 500 from the previous week’s unrevised average of 426,250.
If we combine this with the previous numbers in this series we see that the headline weekly figure has been over 400,000 for twelve weeks in a row now. Also the four-week average has nudged higher and is well over 400,000. So the improving trend of the early part of 2011 has ended and we are back to similar figures to those we saw in January. I expect these numbers to influence the employment report for June because we have had only one poor monthly report so far but twelve poor weekly initial claims figures.
Accordingly QE2 has ended on a sour note if we look at the trend for unemployment. Yes the level of unemployment has fallen since it began so there has been some progress but the current level of initial claims implies that it might now continue the rise we saw in May which reversed some of the improvement. The real issue with this is that we were supposed to be solidly in an economic recovery by now and instead we have more questions and more problems.
The Rise of the ninety-niners
For those unaware the significance of the phrase ninety-niners is that after 99 weeks official US unemployment compensation runs out. If we look at the numbers for Extended Unemployment Compensation and Extended Benefits then it looks like around 27,300 people found themselves in this position last week. They find themselves in a grim position where not only has the official help run out but the duration of their unemployment makes it ever harder to get another job.
Comment on the end of QE2
We will have to see how things settle down in the coming weeks and months but as we stand QE2 has had very patchy results to say the least. I have reviewed the comments when it started and many were claiming then that the objective was to reduce bond yields and instead they have risen. If we look an unemployment an initially improving trend has shown signs of reversing. Critics of the policy,which include me, would further argue that the liquidity created by this programme has contributed to the commodity price boom that we saw in the early part of 2011 which had the follow-on impact of raising food prices which then was a major cause of the so-called Arab Spring.
The one clear positive from the programme has been the improvement in US equity prices. This should have a positive influence on the US economy via wealth effects but such effects are quite weak.Perhaps also we can add that the US housing market has started to show it is not declining as fast as it was and may be beginning to stabilise. But this is a long way short from the hopes that the Federal Reserve must have had back in early November 2010 when QE2 was announced. Also we have to factor in the fact that at end of 2010 we saw the US government extend what is still a very expansionary fiscal policy.
The US debt ceiling
This is a relatively simple concept where the US Congress has set by law that the United States cannot borrow more than US 14,300 billion dollars and this is what is called the debt ceiling. However this was actually hit in the middle of May and as it would have been headline news around the world if the US government had closed down I think we can be sure it has not! What is actually happening is that various tricks and ruses are being used so that whilst officially the debt ceiling remains in reality it has been exceeded, an example of this is that various instruments on the Federal Reserves balance sheet have been used to help in this. Something needs to be done by early August as the tricks and ruses will run out then.
I expect a solution to be found as the shock effect of defaulting will focus political minds out of their current logjam. However it is the same politicians who put the US in this position when at the end of last year they approved the new extra fiscal stimulus or when in April they approved a budget deficit of US $1700 billion for this fiscal year. So yet again I find myself shaking my head at their willingness to ignore reality….
The Price of Corn
Yesterday we got something of an ironic and symbolic present for the end of QE2. The price of a bushel of corn fell by 70.5 cents or just over 10%. Please do not misunderstand me whilst I do feel that QE2 contributed to the rise in commodity prices I would be surprised to find that its end directly caused this drop in corn prices.
Actually the circumstances of the drop reminded me more of the plot from the film Trading Places where the official estimate of the orange juice crop if I remember rightly was less of a surprise to some than it was to others. On this occasion the US Department of Agriculture released a much more optimistic report on the state of the corn crop than was expected. I have to confess I do wonder how supposedly professional traders were this badly wrong-footed.
It also makes me think of the influence of official institutions on markets. Only a week or so ago we saw the International Energy Agency release reserves to reduce the oil price and this week we see the USDA produce a report leading to fall in corn prices. Or to be more specific we may be seeing the response of official institutions to the effects of past official action as the rises in these prices was strongly influenced by the amount of liquidity that central banks have unleashed upon the world. The more I think like that the more I am convinced that this is a long way from the way that capitalism is supposed to be and that rather than being the solution to our problems they are in fact part of the cause.
A Troubling development
From the Bank of England
In parallel with the Bank of Canada, the European Central Bank, and the Swiss National Bank, the Bank of England is today announcing an extension of its temporary swap line with the Federal Reserve to Wednesday 1 August 2012. The Bank of Japan will consider the extension at its next Monetary Policy meeting.
I will leave you with a simple question about this, why is this still necessary when in the early part of 2010 it was considered to be no longer necessary?
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